The Two Variable Model:CEO Salary and Returnon EquityApplied EconometricsWalter Sosa-EscuderoSource: Wooldridge (2009)Motivation and DataGoal: study how CEO salaries are tied toperformance.Data: 209 CEO’s for 1990Source: Business Week (5/6/91)Salary: annual salary in thousands ofdollarsROE: return on equity: net income / total equity (a measure of performance)A quick look at the data…Basic statistics0 5000 10000 15000salary0 20 40 60roeA rather weak relationship.0 1000 2000 3000 4000salary0 20 40 60roeModelOur model will beSalary = a + b roe + uWe will estimate parameters using theleast squares method.Regression output0 5000 10000 150000 20 40 60roeFitted values salarysalary^ = 963.191 + 18.501 roeInterpretations Overall, the fit is poor: R2=0.0132. Means only 1.32% of the variability in salaries is explained by performance. If roe increases in one point, then salary is expected to change in about 18.5 thousands. Prediction: if roe=30, then the predicted salary is963.191+18.501*30=1,518,221The t-statistic for roe is 1.66. This statistic test the null that roe is not-significant. What can you conclude from
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